Of course, China is the second largest economy in the world behind only the United States. It accounts for about 15% of the world’s economic activity and much more of the world’s economic growth. According to the International Monetary Fund, the Chinese economy from 2013 to 2018 accounted for nearly 50% of the total economic growth in the world. That helps explains why the Chinese slowdown matters to just about everyone.

Chinese officials are already working to jump start growth. China reduced the required reserve ratios for banks last week in an effort to spur credit growth. When China cut reserve requirements in 2015, industrial production growth stabilized above 6%. That was also the year China juiced sales by cutting taxes on new car purchases.

Goldman Sachs economist Jan Hatzius sees things stabilizing for China and for other emerging market economies. He recently wrote that “the detente in the trade row between the U.S. and China has (for now) provided some relief. And he noted signs of growth in emerging market countries outside of China.

The trade war

Resolving the trade war and reversing China’s economic slowdown are inextricably linked. Apple CEO Tim Cook blamed tariffs for the revenue shortfall the company announced last week, which hammeredApple
stock (AAPL). If that feels like a stretch, more executives, like
Cognex
CEO John Curran have told Barron’s that “customers are tentative in China.”

Trade fears hovered over the market for most of 2018, but they intensified after the latest round of tariffs in September. On third-quarter conference calls, many companies tried to estimate the cost impact from higher prices for imported components. But few executives offered much context about losses from tertiary tariff impacts, like demand destruction due to higher prices.

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According to the World Trade Organization, China’s average tariff rate on nonagricultural products is about 4%, and the U.S. levies nonagricultural incoming goods at a rate of about 2.3%. That means tariff rate reduction may not be the biggest issue facing negotiators. Instead, intellectual property protection and market access will likely be the more significant topics.

Right now, it appears the market doesn’t know what to expect for the steel business. Steel equities are down nearly 30% over the past year, even as steel prices have risen 8%. Investors aren’t convinced steel tariffs are here for the long term.

Industrial companies and farming are the other two sectors significantly impacted by tariffs. Before tariffs took effect, 35% of China’s soybean imports and 58% of China’s aerospace imports came from the U.S., according to HSBC. And Chinese soy and plane purchases accounted for more than 18% of total U.S. exports.

U.S. industrial stocks have fallen about 16% year-over-year and are off nearly 20% from their 52-week highs. Trade tensions have helped send industrial earnings multiples from about 17 times next year’s estimated earnings to only about 12 times next year’s estimated earnings. Confidence about a rebound in Chinese growth after a new trade deal could send industrial multiples back to their long-term average of about 15 times next year’s estimated earnings.

The Fed

It has been a long slow cycle of tightening for the Federal Reserve. It’s taken the Fed about three years to raise rates by 2.25%. Often when the Federal Reserve raises rates more than 2%, the U.S. economy falls into recession. That has not the case this time—at least not yet. That might be because of the unique starting conditions. The Federal Reserve balance sheet remains at about $4 trillion. That has over 400% higher than at the start of the financial crisis. And 10 year treasury yields are at about 2.7%. That is 1% lower than the last 20 years, when yields averaged just under 3.8%.

Even with low historic rates, many industries still felt pain in 2018. Thirty-year mortgage rates have risen 0.7% year-over-year, and housing stocks fell about 30% in 2018. The 2 year/10 year treasury yield spread compressed by about 0.5% in 2018, and bank stocks fell 20% last year. Many banks borrow short term money and lend it for longer periods. A flattening curve crimps margins.

Federal Reserve chairman Jerome Powell said on Friday that he wasn’t on a “preset” path of rate increases. Investors cheered and the
Dow Jones Industrial Average
rose 745 points. Even if Powell does raise rates a couple more times, all signs indicate that this tightening cycle is close to being done.

Oil

Lower oil prices benefit consumers, but it makes life harder on industrial and energy companies that make up about 14% of the
S&P 500.
Energy producers in the S&P 500 dropped 20% in 2018, energy service providers dropped 42%, and industrial companies fell 15% last year.

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The
Credit Suisse
energy team expects oil prices to bottom in the first quarter of 2019. And KeyBanc expects West Texas Intermediate crude prices will average between $50 and $60 for the full year. That has higher than the current price of $47.98 per barrel. Goldman Sachs analyst Neil Mehta still sees value in
Chevron
stock (CVX), pointing out that the company can cover its dividend at $50 Brent crude prices. Brent closed on Friday at more than $57 per barrel.

Those are the ifs—the four big issues investors will grapple with in 2019. It might seem unlikely, but there does appear a path for all of the ifs to be resolved without much additional stock market pain.

If that happens and sentiment shifts, then perhaps market gains in 2019 could surprise investors, just as the fourth-quarter stock market losses left investors reeling last year. That would be a nice story.

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